Commercial tenants typically pay a monthly rent for leased space for offices or the like based on the square footage of the space. Landlords typically calculate commercial office rental rates based on taxes, operating expenses, debt service, tenant construction costs, marketing costs and profit (or return on landlord investment). Landlords evaluate these costs on a per-square-foot basis. The only part of the rent a tenant typically can negotiate is the profit segment, which is usually 5% to 15% of the total rental rate because all of the other landlord expenses listed above are predominantly fixed. By reducing the amount of space required by a tenant, however, the effect is cost reduction on the entire rent, not just the profit portion. A tenant may thus realize substantial rent savings if they reduce the space they lease by identifying and eliminating areas in their space that are no longer needed or can be downsized, reducing inefficient architectural designs and avoiding buildings that have low efficiency ratings.
In view of the above, it is becoming increasingly important for tenants to accurately determine the amount of leased space that they actually require so design and architectural inefficiencies can be identified and eliminated. Real estate leasing firms, brokers and professional licensed architects predominantly use a multiplier to calculate space requirements. For example, the multiplier could be 200 square feet per person so that a company with 50 people would have a calculated requirement of 10,000 square feet. But some industries need more space per person because of the size and mix of executive offices and workstations. For example, attorneys and accountants may need 250-300 square feet per person because they typically use a higher ratio of offices to cubicles. Insurance companies and software consultants, however, use more cubicles than offices and may need only 150 square feet per person.
In addition, real estate leasing firms and architectural firms typically don't consider that every company has its own distinct space requirements. An analysis of the needs of two companies with similar revenues in the same industry may provide two very different results. For example, one company might want a twenty-person boardroom while the other wants a twelve-person conference room. One may decide a 6′×6′ cube is big enough for employees while the other will opt for 8′×8′ workstations (almost double the space). One president might want a modest 12′×15′ office, the other a 20′×30′ oasis with a private washroom and a wet bar. Companies may also have their own set of workspace standards, which can vary as much as 75% across an industry. Despite this variety of company needs, brokers and architectural firms typically still use the antiquated ‘rule of thumb’ multiplier approach to estimate space requirements, which often leads to considerable over-sizing of the tenant's space.
Another disadvantage for tenants in the ‘how much space do you need?’ scenario is the fact that landlords, as a marketing device, often offer free space planning to potential tenants. Oftentimes, however, the landlord's architect does the planning. This is beneficial for the landlord, who usually negotiates a ‘quantity discount’ rate with the architect for the planning services, but not so beneficial for the tenant because the architect is paid by the square foot. As a result, the larger the space architects lay out for tenants, the more the architects are paid. Both the architect and the landlord therefore want to see the tenant contract for as much space as possible. As a result, efficient space planning is rarely emphasized by landlords or their architects.
Building spaces often feature inefficiencies which reduce the amount of actual usable square footage and, in turn, increase the amount of space tenants will need to lease. More specifically, because of numerous factors, the space efficiency of buildings varies greatly. Columns, HVAC apparatus, building loss factors and unusual building shapes (curved sides and any angles other than 90°) increase space inefficiency and are all elements that can vary greatly from building to building. As a result, the actual usable space that is available to a tenant is actually less than the amount advertised by the landlord. Because of these varying inefficiencies from building to building, one building will require a 10,000 square foot space for a tenant while another less efficient building will need 11,000 square feet for identical tenant requirements. Using this “space efficiency” concept, a tenant can realize substantial rent savings.
In addition, when a tenant's office lease is coming due, it is typical for that tenant to negotiate that lease by soliciting proposals from other buildings that have available space for lease that will meet their requirements. This creates a competitive bidding environment and usually results in more favorable lease terms for the tenant. Although it is common for the tenant to hire a real estate broker to represent them, the tenant may alternatively elect to handle these negotiations themselves.
One of the early stages of negotiating an office lease involves determining how much space the tenant will require. The next stage is then identifying which buildings have enough contiguous space available to house the projected space requirement. Furthermore, identifying the buildings may also include such parameters as budget (identified by rental rate and/or anticipated rent), quality of building, amenities and location. Since the entire process of considering alternate buildings (and moving if it is determined that an alternate location is preferable) can take 6 months to 18 months depending on the size of the tenant, it is important to include all buildings that will be potential alternatives for the tenant. Adding buildings for consideration in the middle of the process is difficult and time consuming, often delaying the project. Because leases generally have a definitive expiration date, and severe penalties for tenants that hold over (stay in their space beyond their lease expiration), it is important that the process of negotiating a new office lease stay on schedule.
During lease negotiations, there are many issues that can delay the process, cause unnecessary duplication of work, weaken the negotiating position of the tenant and/or put the tenant in jeopardy of paying severe hold over penalties mentioned above. Many of these issues revolve around the amount of space the tenant will require in any particular building.
For example, it is desirable to start with at least 3 or 4 viable options to consider when negotiating an office lease. This is because there are instances when a tenant's “preferred building” may get leased by another tenant in the middle of the transaction. Additionally, an otherwise reasonable landlord may suggest a very unreasonable term to the tenant very late in the transaction, causing them to eliminate that building from consideration.
In consideration of the above, it is imperative that the initial buildings be carefully chosen and pre-qualified to ensure that they are in fact realistic alternatives for the tenant, ensuring the tenant will not “run out of options” by the end of the negotiations and stand a chance of either holding over in their current office space or losing negotiating leverage with their existing landlord.
Despite the importance of identifying truly viable options in the negotiating process, there are many space related issues that can and do arise which prevent this from occurring.
For example, a tenant searching for buildings that have 20,000 square feet of space may include a building in their initial “short list” (buildings that are selected to receive proposals from), only to find out much later in the process that, because of inefficiencies in the building that cause additional square footage to be leased, their requirements will not fit in the same 20,000 square feet that is needed in another, more efficient building.
Additionally, a tenant may have a strict rent budget of $400,000 annually (which translates to $20.00/foot/year on 20,000 square feet). In this instance, the tenant may select a building that is quoting a $20.00 per square foot rental rate. Again, if it is determined late in the process that because inefficiencies in the subject building cause additional square footage to be leased, their requirements will not fit in the same 20,000 square feet that is needed in another, more efficient building. For the purposes of this example, the tenant's requirements may fit into 22,000 square feet and no less. Therefore, even if the building had the additional square footage to fit all the tenant's requirements, the building would no longer be a candidate because their rental rate at $20.00 per square foot will cause them to go 10% over budget.
Lastly, if the tenant has incorrectly projected they will need more space than they actually do, they may eliminate a building because it does not meet the minimum square footage desired by the tenant. However, if the tenant knew that it could fit into 18,000 square feet, instead of the 20,000 square feet it incorrectly projected, the tenant may eliminate a building that otherwise would have made their short list.
It is therefore highly desirable for a tenant to be able to project the amount of space that will be required in any office building during the early stages of building selection. This additional capability will allow the tenant to: 1) Eliminate buildings that will not have enough space for them, 2) eliminate buildings from consideration that will cause them to lease additional space that will, in turn, cause them to go over budget, 3) include buildings that may have otherwise been eliminated because it was believed they did not have enough space (when in fact, they do) and 4) understand each building's relative value by looking not only at rental rate, but a factor or rental rate and building efficiency, in turn enabling them to make more educated decisions while deciding which buildings they will solicit proposals from.